Local Bank Financing for Smallholder Farmers

By Sara Wallace, Initiative for Smallholder Finance

Local Bank Financing for Smallholder Farmers

Over two billion of the world’s poorest people live in households that depend on agriculture for their livelihoods. The 450 million smallholder farmers within that group are a linchpin to global poverty-reduction.

Yet most smallholders lack access to finance, holding them back from producing larger crop yields of higher quality to propel both economic growth and poverty alleviation.

New research from the Initiative for Smallholder Finance reveals that local bank lending to smallholder farmers – which should be a main avenue for improving their access to finance – amounts to only $9 billion, barely scratching the surface of the $300 billion demand for smallholder financing.

Understanding the current size and scope of local bank lending to smallholders – and, perhaps more importantly, the constraints that banks and farmers face – can help donors, businesses, and financial institutions target their efforts and improve access to finance for smallholders worldwide.

The profitability of lending to smallholders is not the cause of the gap; rather, constraints facing both banks and farmers stymie the flow of finance.

The study by the Initiative for Smallholder Finance surveyed 1,800 banks in South and South East Asia, Latin America, and Sub-Saharan Africa and found that only 290 (or 16%) provided smallholder farmer financing. Most (80%) of the existing supply comes from public policy banks or state and agricultural development banks that were established by local governments before becoming fully or partially privatized.

The lack of supply is exacerbated by the difficulty smallholders have in acquiring even the existing loan products. These farmers work on fewer than two hectares of land, and typically do not belong to producer organizations or structured value chains. They often have low financial literacy and financial management skills, and their businesses have low productivity, margins, and cash flow – all characteristics that make it difficult to service a loan. Lack of formal financing sources forces most smallholders to rely on expensive informal credit, where they often pay interest rates 2x-10x higher than commercial rates.

Banks, too, face challenges – even if they’re interested in serving smallholders. Banks need the appropriate agricultural expertise to assess smallholder loan risk and design suitable financial products, but most lack or have difficulty acquiring this expertise. This issue is not making the lending profitable – banks surveyed in this study report that they can offer smallholder products profitably – rather, the barrier seems to be entering the market, which requires large upfront investments in staff skills, technology, and back-office processes that cannot be recouped unless the smallholder lending will reach large scale.

A recent piece by One Acre Fund published in Business Fights Poverty highlighted the importance of innovation when it comes to serving smallholders. Opportunity Bank in Uganda, for example, has succeeded in serving 3,600 smallholder clients by tailoring both products and distribution methods. The bank offers microfinance products tailored to the crop cycles of farmers and works with partners who sign agreements with farmer groups to offer savings and microloans guaranteed by the group. Opportunity Bank also uses mobile branches and roaming bank agents to reach farmers in rural areas.

Programs focused on guarantees are treating the symptoms, not the cause

To help smallholders, donors have thus far focused on creating incentives for banks to lend to smallholders by offering guarantees, yet in spite of these, lending remains sluggish. Guarantees do not address banks’ fundamental need for investment capital and expertise to build distribution and back-office infrastructure for serving smallholders. As one banker in Kenya attested, “Most donors don’t do training for loan officer staff, so guarantees may just encourage irresponsible lending in the agricultural sector.”

Currently, most funding for technical assistance in the smallholder value chain is targeted directly at smallholders, while only 3% is directed toward banks. Only 8-10 of the largest technical assistance providers in the world have credible programs focused on banks, As a result, even banks eager to enter the market may find it difficult to acquire the necessary expertise. Among these technical assistance providers, Rabo Development and Grameen Credit Agricole have effectively moved local banks and microfinance institutions into the smallholder banking market by making equity investments and offering training and technical support to improve banks’ capabilities.

Local bank financing for smallholder farmers represents a huge opportunity for banks within an even larger opportunity to target the entire agricultural sector. For local bank smallholder financing to expand, donor support must move toward balanced support for investment capital and supply-side technical assistance. The effects would be enormous: if local banks increased capacity to serve smallholders, they would support over two billion of the world’s poorest people who rely on agriculture for their livelihood.

Read the full Initiative for Smallholder Finance briefing document, “Local Bank Financing for Smallholder Farmers: A $9 Billion Drop in the Ocean.”

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